What Is Absolute Advantage?

What Is Absolute Advantage?

Let me explain absolute advantage directly to you: it's when an entity establishes dominance over competitors by producing more with the same inputs. You achieve this by creating a good or service at a lower absolute cost per unit, using fewer inputs or a more efficient process.

Key Takeaways

Here's what you need to know: absolute advantage means a producer can deliver a good or service in greater quantity for the same cost, or the same quantity at a lower cost, compared to competitors. Adam Smith developed this concept, showing it as a foundation for significant trade gains between producers with different absolute advantages. Through specialization, division of labor, and trade, producers with varying advantages always benefit more than if they produced in isolation. Remember, this contrasts with comparative advantage, which involves producing at a lower opportunity cost.

Understanding Absolute Advantage

Adam Smith introduced absolute advantage in his book 'The Wealth of Nations' in the 18th century to demonstrate how countries gain from trade by specializing in goods they produce more efficiently than others. If you're a country with this advantage, you can focus on producing and exporting that specific good or service, then use the proceeds to buy what others make better.

Smith argued that by specializing in products where they hold absolute advantage and trading them, all countries end up better off, provided each has at least one such product over others. This explains why it makes sense for individuals, businesses, and nations to trade: each has strengths in certain areas, and exchange benefits everyone involved.

This mutual benefit from trade underpins Smith's view that specialization, division of labor, and trade increase overall prosperity, which he saw as the source of the 'Wealth of Nations'.

Absolute Advantage vs. Comparative Advantage

You should distinguish absolute advantage from comparative advantage, where a producer has a lower opportunity cost for a good or service than another. Opportunity cost is what you miss out on by choosing one option over another.

Absolute advantage guarantees clear gains from specialization and trade only if each producer has it in some good. Without it, Smith's argument doesn't directly apply. However, producers can still gain from trade by specializing based on comparative advantages, as David Ricardo argued in 'On the Principles of Political Economy and Taxation'. Even if a country excels absolutely in many goods, it benefits from trading with others that have different comparative advantages.

Assumptions of the Theory of Absolute Advantage

Both Smith's absolute advantage and Ricardo's comparative advantage rely on assumptions that simplify trade benefits. They assume no barriers to trade, ignoring shipping costs or tariffs that affect real-world decisions. Countries can use tariffs to create advantages or disadvantages.

These theories also assume immobile factors of production, meaning workers and businesses don't move for better opportunities—a realistic view in the 1700s, but globalization now allows factories to relocate and increases immigration, impacting workforces.

Crucially, they assume constant absolute advantages that scale equally, with per-unit costs unchanged regardless of production volume, and countries unable to alter their advantages. In reality, strategic investments can create advantages, and events like natural disasters can destroy them.

Pros and Cons of Absolute Advantage

One pro is the theory's simplicity: it clearly shows how countries benefit by trading on their advantages. But it doesn't fully explain trade benefits, which Ricardo's comparative advantage covers better—even if one country produces everything cheaper, trade still helps.

The theory assumes static advantages without scale efficiencies, yet countries have built advantages through investments. Historically, it's justified exploitative policies, like pressuring developing nations to stick to agriculture instead of industrializing, keeping them underdeveloped.

Example of Absolute Advantage

Consider two hypothetical countries, Atlantica and Pacifica, with equal populations and resources, each producing butter and bacon. Atlantica can make 12 tubs of butter or 6 slabs of bacon yearly, while Pacifica can make 6 tubs of butter or 12 slabs of bacon.

Each needs at least 4 tubs of butter and 4 slabs of bacon to survive. In isolation, Atlantica spends one-third on butter and two-thirds on bacon for 4 of each; Pacifica does the reverse for the same. They're barely surviving.

But Atlantica has absolute advantage in butter, Pacifica in bacon. If they specialize—Atlantica makes 12 butter, Pacifica 12 bacon—and trade 6 each, both end up with 6 of each, better than before.

How Can Absolute Advantage Benefit a Nation?

Adam Smith showed in 'The Wealth of Nations' how nations gain by specializing in efficiently produced goods for export and importing others' efficiencies. As long as each has an absolute advantage in at least one product, both benefit from trade.

How Does Absolute Advantage Differ From Comparative Advantage?

Absolute advantage is producing at lower absolute cost with fewer inputs or better efficiency. Comparative advantage is producing at lower opportunity cost, not necessarily higher volume or quality.

What Are Examples of Nations With an Absolute Advantage?

Saudi Arabia has absolute advantage in oil due to abundant supplies. Colombia's climate gives it advantage in coffee, Zambia in copper mining. For Saudi Arabia to grow coffee or Colombia to drill oil would be costly and inefficient.

The Bottom Line

Adam Smith's theory of absolute advantage explains trade benefits through exporting where you have advantage and importing elsewhere. It's a simple illustration, but Ricardo's comparative advantage better explains full international trade benefits.